The Securities and Exchange Commission (“SEC”) recently brought two enforcement actions against public companies regarding related party transaction (“RPT”) disclosures. The actions against Lyft and Maximus should remind public companies to make sure that their RPT disclosure controls are effective and warn them about the severe consequences that can follow from disclosure violations.
Background: The Disclosure Requirement
A public company is required to disclose information about transactions involving the company and its directors, executive officers and other enumerated parties in its proxy statements or annual reports on Form 10-K. Transactions that must be disclosed include any transaction since the beginning of the company’s latest fiscal year, or any currently proposed transaction, in which:
- the company was — or is to be — a participant;
- the amount involved in the transaction exceeds $120,000; and
- any “related person”1 had — or will have — a direct or indirect material interest.
When an RPT must be disclosed, the company must describe the transaction, including:
- the related person’s name and relationship to the company;
- the related person’s interest in the transaction with the company, including the related person’s position or relationship with, or ownership in, a firm, corporation, or other entity that is a party to — or has an interest in — the transaction;
- the approximate dollar value of the transaction and of the related person’s interest in the transaction; and
- any other information regarding the transaction or the related person in the context of the transaction that is material to investors in light of the circumstances of the particular transaction.
Recent SEC Enforcement Actions
On September 18, 2023, the SEC announced settled charges with Lyft Inc. (“Lyft”) for failing to disclose a Lyft director’s role in a large shareholder’s private sale of approximately $424 million of shares of Lyft prior to Lyft’s IPO. According to the SEC’s order, prior to Lyft’s IPO in March 2019, a Lyft director arranged for a shareholder to sell its shares to a special purpose vehicle (“SPV”) set up by an investment adviser affiliated with the same director. The director then contacted an investor interested in purchasing the shares through the SPV. Lyft approved the sale and secured a number of terms in the contract. The director (who left Lyft’s board at the time of the transaction) received millions of dollars in compensation from the investment adviser for his role in structuring and negotiating the deal. The SEC order states that the director “did not disclose his compensation or his material interest in the transaction to Lyft.” As a result, Lyft failed to disclose information regarding the sale in its Form 10-K for 2019. Without admitting or denying the SEC’s findings, Lyft agreed to a cease-and-desist order and to pay a $10 million civil penalty.
On September 11, 2023, the SEC announced settled charges against Maximus, Inc. (“Maximus”) for failing to make required disclosures related to Maximus’s employment of the siblings of one of its executive officers. According to the SEC’s order, Maximus appointed a longtime employee as an executive officer in 2019. The officer’s two siblings were also longtime employees of Maximus who each received annual compensation in excess of $120,000. Maximus filed annual reports and proxy statements for fiscal years 2019 through 2021 that did not disclose this information. Without admitting or denying the SEC’s findings, Maximus agreed to pay a civil penalty of $500,000.
These recent actions join many other SEC enforcement actions about failures to disclose related party transactions, including In re The Walt Disney Company (Dec. 20, 2004) (compensation to family members, payments to affiliated corporations of directors, and other transactions), SEC v. Keyuan Petrochemicals (Feb. 28, 2013) (numerous types of transactions with directors, officers and large shareholders and a secret, off-balance sheet account for payments and perquisites to senior officers), In re Eagle Bancorp, Inc. (Aug. 16, 2022), (bank loans to a family trust associated with the CEO and other related parties), and In re The Greenbrier Companies, Inc. (Mar. 2, 2023) (charter of CEO’s private aircraft from a third-party aircraft management company).
Takeaways for Public Companies
The Lyft and Maximus cases suggest a few lessons:
- Disclosure Violations Can Have Severe Consequences. The documents that the SEC made public contain no evidence that either Lyft or Maximus acted nefariously or attempted to “hide the ball” with respect to the RPTs at issue. In fact, the SEC stated that the Lyft director did not disclose his interest in the transaction to Lyft and noted favorably that Maximus had self-reported its issue. It seems more likely that both of these companies simply did not realize that they had disclosure obligations with respect to these transactions. Nonetheless, the proceedings — and, most notably, the negotiated monetary penalties — make clear that the SEC takes the RPT disclosure requirements seriously.
- The RPT Disclosure Requirements Are Nuanced and Complex. One of the reasons Lyft and Maximus may not have fully appreciated their disclosure obligations is that the RPT disclosure requirements are complex and, in many cases, subject to interpretation. In the Lyft case, the transaction did not involve a payment between Lyft and a related party. Nevertheless, RPT disclosure is required where, assuming the other requirements are satisfied, a registrant is a “participant” in the transaction. This includes situations where a company benefits from a transaction with a related person that the company has arranged or in which it participates, even if the company is not a party to the contract. In finding that Lyft was a “participant” in a sale of Lyft’s shares to a third party, the SEC noted that the approval of Lyft’s board was required under a shareholders’ agreement for the sale, a special committee of the board reviewed the sale, and Lyft negotiated for and secured various commitments from the seller and the buyer as a condition to the committee’s approving the sale.
- Companies Should Revisit Best Practices. Best practices that public companies should consider to comply with the RPT disclosure requirements include:
- Regularly review and, if advisable, update the company’s RPT policies. This process should involve consideration of the best person or department at the company to be notified of the facts and circumstances of potential RPTs and submit them to the board or a committee of the board for review and approval. The process should also involve consideration of which directors or board committee will oversee and administer the policy. Companies should also remember that the stock exchanges have specific rules and requirements concerning RPTs and should make sure their policies and procedures reflect the latest rules of the applicable stock exchange.
- Merely having and regularly reviewing and updating an RPT policy is not enough. Companies should also regularly communicate (at least annually) with directors, executive officers and director nominees to make sure that they are aware of the existence of the policy (and what it requires).
- Regularly educate directors, director nominees and executive officers on the RPT disclosure requirements so that all relevant transactions are identified and brought to the attention of the appropriate people. Related persons should understand that they have an affirmative obligation to notify the company of potential RPTs to facilitate compliance with the RPT disclosure requirements (as well as the company’s RPT policy).
- Ensure that the company’s form D&O questionnaire takes into account the RPT disclosure requirements. Additionally, consider implementing additional protocols (above and beyond the annual D&O questionnaire process) to help identify RPT transactions on a real-time basis, including requiring related persons periodically to submit a list of names of immediate family members and entities with which they and their immediate family members are affiliated. The company can then regularly cross check this list against internal records to determine whether any of these covered people/entities have engaged in transactions involving the company that involve more than $120,000.
- Ensure that compensation to immediate family members of related persons is approved by a committee of the board comprised of disinterested independent directors. This is likely a requirement of the company’s RPT policy and should also help facilitate compliance with RPT disclosure requirements.
- If a director previously identified as “independent” under applicable stock exchange rules enters into an RPT, consider the effect of the RPT on the director’s independent status or committee eligibility.
1 “Related persons” include directors and executive officers of the company, or their immediate family members, and 5% shareholders of the company, or their immediate family members.